EUROPEAN COMMISSION PROPOSAL FOR REVIEW OF

UNCLAS SECTION 01 OF 02 BRUSSELS 001657 SIPDIS PLEASE PASS TO USTR PLEASE PASS TO FED, SEC STATE FOR E, EEB A/S SULLIVAN, EUR/ERA, EB/OMA NSC FOR K. KVIEN E.O. 12958: N/A TAGS: EFIN ETRD ECON EUN SUBJECT: EUROPEAN COMMISSION PROPOSAL FOR REVIEW OF CAPITAL REQUIREMENT DIRECTIVES ¶1. SUMMARY. On October 1, 2008, the European Commission unveiled its proposal to amend the Capital Requirement Directives (2006/48/EC and 2006/49/EC) through a combination of co-decision and comitology proposals. The Co-decision proposal contains the more fundamental changes that must receive approval from the European Parliament and the Council. Under the proposed rules: 1) banking institutions will be required to hold a higher amount of capital to protect themselves against the risk of default; 2) ad-hoc Colleges of Supervisors will supervise banks with cross-border operations; and 3) financial institutions that originate securitized products will be required to keep five percent of the securities. DETAILS OF THE PROPOSALS -------------- ¶2. MANAGEMENT OF LARGE EXPOSURES: Banks will be required to limit their exposure to a client or a group of connected clients to twenty five percent of their Tier 1 capital (or 150 million, whichever is higher). Some exceptions remain, such as exposures to sovereign and regional governments, local authorities, cooperative banks and others detailed in the Directive. ¶3. SUPERVISION OF CROSS-BORDER BANKING GROUPS: QColleges of SupervisorsQ will be established for banking groups that operate in multiple EU countries. Each banking group will be supervised by an adQhoc college whose composition will vary depending on the cross-border nature of the group. Decisions on key supervisory aspects will be jointly agreed upon by the consolidating (lead) supervisor and the host supervisors, with the final say for the consolidating supervisor (and a mediation mechanism in case of disagreement). This will affect the current supervisory architecture, the so-called Pillar 2. Colleges of supervisors will also coordinate the liquidity risk management of banking groups that operate in multiple EU countries. ¶4. QUALITY OF BANK CAPITAL. There will be clear EU-wide criteria for assessing whether 'hybrid' capital is eligible to be counted as part of a bank's overall capital. (There is currently no EU- wide legislation defining what types of hybrid capital can be counted.) For hybrid capital to be recognized as Qoriginal own fundsQ (i.e. Tier I capital),it needs to: be able to absorb losses, allow the cancellation of payment in times of stress, be deeply subordinated during liquidation and must be permanently available, i.e. either undated or with an original maturity longer than 30 years. Hybrid capital can, however, be callable earlier, but only at the initiative of the issuer, with supervisory approval and if it is replaced with capital of the same quality. The proposal also sets quantitative limits on the use of hybrid capital to discourage institutions from relying extensively on it to the detriment of QcoreQ capital. ¶5. RISK MANAGEMENT FOR SECURITIZED PRODUCTS: Rules on securitized debt will be tightened. Originators will be required to retain some risk exposure to these securities (no less than five percent of the total originated) while firms that purchase the securities will be allowed to do so only after conducting comprehensive due diligence. If they fail to do so, they will be subject to significant capital penalties. The proposal also lowers the capital requirements for less risky assets held by Collective Investment Undertakings (CIU) but maintains high capital charges where the assets are either high risk or the actual risk is not known. ¶6. In addition to the above co-decision proposal, the Commission also plans to introduce certain technical changes that were approved by the European Banking Committee and have been submitted to the European Parliament for scrutiny. These technical changes address inconsistencies that have been identified during the transposition phase of the CRD, and that must be resolved to ensure that the BRUSSELS 00001657 002 OF 002 effectiveness of the CRD is not compromised. OUTLOOK FOR THE PROPOSAL -------------- ¶7. The European Parliament will now examine the proposal and vote on a report in the Economic and Monetary Affairs Committee. The designated rapporteur, who will lead the parliamentary scrutiny, is Austrian Conservative MEP Ottmar Karas. He will hold a preliminary exchange of views within the ECON Committee on November 4th and 5th. In order for the proposal to be adopted before the end of the current parliamentary legislature (spring 2009),the report will have to be adopted by the plenary no later than January 2009. SILVERBERG